Monday, September 12, 2005

Google back above 300, options and valuation

Lets not forget why we are here. This blog is about how to invest in the so lucrative search industry. Therefore it is nice to see Google back above 300 - welcome back! When the share goes up - so does the options. It depends which options you are looking at. I only consider call options, which is the right to buy the share at a given strike price before a given date. The opposite is a put option - the right to sell, also at a given strike price and before a given date. You would normally buy put options, if you think a company is going to fall in value. Call options are when you believe the share is going to go up.

Options trading is highly risky and should be done with great care. You can be right about a stocks direction, but wrong in your timing. If your timing is off - you loose everything. If you buy a share instead of an option - you only need to be right about the direction - you have better time. However, with the risk comes a reward, when you make the right calls. Today when Google shot up 3.56%, certain january 2007 options went up with 15%-20%. That is a nice return on investment for a single day.

A lot of people say that Google is overvalued. Is it? Personally I don't think so. You have to look at the value behind the company. How much are they generating in revenue are they growing? I like to use EBITDA (Earnings Before Income Tax, Depreciation and Amortisation) on a quarterly basis. It says something about the companys ability to generate current and future revenue. In growth areas like the search industry the quarter one year ago don't mean much to me. Instead I take the last quarter and time it with four. This is how much the company is making EBITDA on a yearly basis. You take the valuation of the company (market capitalisation) and divide it by the EBITDA and you have how much you are paying for $1.- EBITDA in the company - also called P/E (Price/Earning).

Certainly Google has gone from an IPO $85 to $309. In the same time Google quarterly EBITDA have risen from $255 mio to $590 mio. Yes, the stock has gone up more than EBITDA, however, at the same time Google has really made a gap to Yahoo!s EBITDA, which currently is at $368 mio. This rightfully puts a premium on Google, since its the top dog in the industry. Top dogs have more money for research and improvements etc. Even before Google existed - do you remember how Yahoo! left Excite, Lycos and Infoseek in the dust? Also rather important Google is currently growing EBITDA at a rate of 112% yearly, while Yahoo! is growing the same number with 57% per year.

Google P/E at the moment is 36,5 while Yahoo! is 32,5. So you are almost paying the same for one dollar in earnings in the two companies - despite the fact, that Google is growing almost twice as fast. Wouldn't you rather want to own a piece of the faster growing company?

When this is said, Googles CEO Eric Schmidt has mentioned, that current quarter might not excactly hold the same growth as earlier quarters.


Anonymous said...
This comment has been removed by a blog administrator.
Joackim Penti said...

Good insight in tomorrows kings! No doubt Google will be on top for a long time. I look forward to keep track through this blog :-)

Anonymous said...

The meaning of do no evil